Good day, ladies and gentlemen, and welcome to the Advanced Energy Industries Q1 2019 Earnings Conference Call. Currently, all participants are in a listen-only mode. [Operator Instructions] Also as a reminder, this conference call is being recorded. At this time, I'd like to turn the call over to your host Edwin Mok, Vice President of Strategic, Marketing and Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone. Welcome to Advanced Energy’s first quarter 2019 earnings conference call. With me today are Yuval Wasserman, our President and CEO; Paul Oldham, our Executive Vice President and CFO; and Brian Smith, our Director of Investor Relations. Before we begin, I would like to mention that our Annual Shareholder meeting will be held on Tuesday, June 4th. In addition, during this quarter, Advanced Energy will be participating at Investor Conferences host by JPMorgan, Cowen and Co, Stifel, Citi and NASDAQ. As all these events will occur, we'll make additional announcement. And now let me remind you that today’s conference call contains forward-looking statements including the company’s current view of its industry, performance, products, applications and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in our filings with the SEC. All forward-looking statements are based on management’s estimates, projections and assumptions as of today May 7, 2019, and the company assumes no obligation to update them. Aspirational goals and targets discussed on this conference call or in the presentation material should not be interpreted in any respect as guidance. Today’s call also includes non-GAAP adjusted financial measures, which exclude the effects of discontinued operations, stock based compensation expenses, amortization of intangibles, restructuring charges, acquisition-related costs and other one-time items. Reconciliation between GAAP and non-GAAP measures are contained in yesterday’s earnings release, which is available on our Investor Relations page of our website. We’ll be referring to earnings slides posted on the investor section of our website as well. With that, let me pass the call to our President and CEO, Yuval Wasserman. Yuval?

Thank you, Edwin. Good morning, everyone. And thank you for joining us on this call. Despite the challenging market environment in Q1, Advance Energy delivered solid profitability while continuing to execute on our strategy and invest in critical problems. Industrial technologies delivered solid results this quarter, overcoming slow demand related to consumer electronic market and our server sale held up well in face low utilization and a seasonal slowdown in China. The semiconductor market remains challenging with our customers' changing ordering patterns in a quarter. Through it all, we continue to win a new designs product including several that we expect to drive improvement to our business in the second half of this year. The integration of our recently acquired businesses is progressing on track. As we reduced cost while developing new opportunities. Finally, our team has made great progress in executing on our strategic initiatives. In semiconductors, the environment remain challenging in the first quarter with incremental weakness in our sales into memory applications especially in etch partially offset by some pickup in applications for foundry and logic such as BVD. In addition, as way for fab equipment manufacturers adjusted their production levels and reduced inventories to match the new demand environment, our business with some of them has started to recover. While business with other has continued to decline. For example, as reported in our 10-Q filing, sales to our largest customer decline meaningfully during Q1, while revenue from our second largest customer rebounded. As we look forward, we expect our sales into the semiconductor market in Q1 to decline modestly due to further weakening in the DRAM market and continued inventory adjustment by our customers. Having said that, we believe some improvements in demand are signals for the early stage of market stabilization. And we expect revenues…

Thank you, Yuval, and good morning, everyone. In the first quarter, we felt the continued impact of the semiconductor cycle, partially offset by solid results in industrial. Revenue was within our guidance range for the quarter but below the midpoint mostly due to incremental weakness in the semiconductor industry. Good operating expense control largely offset softer revenues and enabled in line operating profitability. While a discrete tax benefit allowed us to deliver non-GAAP earnings above our guidance range. Total revenue was $140.7 million, down 8.7% from last quarter and down 28.1% from the year ago. Looking at sales by market, semiconductor revenue in the quarter was $67.5 million, down 19.1% from last quarter and 50.4% year-over-year. If you combine our semiconductor product and service related revenue, our total sales in to the semiconductor market declined 15% sequentially and 42% compared to last year's peak. As Yuval mentioned, we continue to see the impact of inventory adjustments and low equipment demand, particularly at our largest customers. While visibility remains limited, we expect a modest sequential revenue decline in Q2 primarily related to DRAM, and revenues for the rest of the year to be around the first half levels, setting up a potential recovery in 2020. Industrial technologies revenue increased 7.3% from the fourth quarter and 26.7% from last year to $44.6 million. The growth from the prior year was largely due to the addition of LumaSense, while the sequential increase was primarily a result of strength in solar, medical and high-voltage, offsetting sequentially weaker sales in flat panel displaying and consumer electronics hard-coating. In fact, Q1 represented our second highest quarterly revenue level ever for PV solar cell applications. In addition for the quarter, LumaSense grew modestly sequentially and will be accretive to earnings. Looking forward to the second quarter, we…

[Operator Instructions] Our first question comes from Tom Diffely from D.A. Davidson. Please go ahead.

Yes. Good morning. Maybe first question on the semi market in general for you. With your new guidance were flattish in the second half. You're looking to be down not quite twice as much as your customers-- your customers but significantly more than your customers. Is that more of a mix related issue or is it the timing issue with you? Maybe expand how you think the differences between you and your customers are for that?

Hi, Tom. It's a combination of product mix, customer mix, inventory correction and timing, all of the above. We see that as basically market driven and customer driven and not anything to do with anything that has to do with share or major changes in our content or position within our customers.

Okay. So I would assume that when the memory market does recover, you would probably outperform for a period of a couple quarters as that inventory especially the working capital inventory starts to build back up.

Exactly right. As we -- as you know we have high content especially in etch applications and as the memory market recovers, we expect to see strong recovery for us.

Okay and maybe just a little bit on your longer-term views of both the flat panel market and the solar market as a driver for the industrial piece.

So the industrial piece really is the key driver for our guidance for decline into Q2 driven mainly by flat panel display demand, hard-coating for electronic consumer products. And the fact that the big solar project that we had in Q1 will not repeat in Q2, although we expect solar to recover in the second half. In general, we expect to see recovery in industrial in the second half. This is basically a timing of projects and market conditions and as you know, both --all these markets tend to be lumpy and investment cycle in these areas can occur in one quarter and not in another quarter.

Okay and then finally for Paul, when you look at the level of operating expenses right now, especially the R&D side. Is that a long-term level of R&D spending do you believe or is it someone needed this year to respond to the slowdown in business?

Well certainly, Tom, we had a target of operating expenses between $47 million and $48 million and embedded in there you can see we've increased our R&D expenses, and held flat or reduced our SG&A expenses. That's fundamentally because we see significant opportunities to grow the business as we come out of this downturn. So at this point we don't anticipate reducing that level. And as the market grows, obviously, we'll have a lot of leverage because we don't think we need to increase it substantially as well. So that's our philosophy is we're trying to keep within that target range. It may bounce a little bit up and down quarter-to-quarter, in Q1 of course, we were able to manage that a little bit better and saw expenses a little lower, but that's our target is to stay within that range for the foreseeable future.

If I may add, Tom. Tom, as we indicated in the past, we're invited to collaborate with key customers on next-generation technology development. And these are project that we believe will transform the way semiconductor devices are being made and for that reason we continue to invest in critical R&D projects even during this cycle. Our expectation that as we emerge from the cycle, we will have a broad in semiconductor applications and new technologies that will enable the industry to go to the next generation devices.

Okay. Maybe just one more quick one. The new production site in Malaysia is that really just to reduce the geographic or are there cost benefits of that facility?

It's all of the above. It's basically allowing us to have a location with less exposure to geopolitical challenges. A second hub to allow us to have better business continuity profile and cost reduction.

Our next question comes from Patrick Ho from Stifel. Please go ahead.

Thank you very much. Maybe first off, in your prepared remarks you mentioned that gross margins were affected by absorption as we look forward to the June quarter. Are there any mix issues given that semis are down again or projected to be down? And that typically tends to be your higher margin products.

Yes, Patrick. It's a good question. We're not projecting a large change in mix and in general our mix between semi and industrial isn't very different. Now within each product area there can be pluses and minuses. So more highly configured tool could carry higher margins within a product family than a lower configured tool. So we don't anticipate that it's a lot of mix change across the different markets. And we don't anticipate that there's a lot of mix change in Q1 to Q2. What we're seeing in the guidance really is the impact of lower volumes. And the fact that we now that we've got a site in Malaysia, we've begun to invest in the transition related to that. As Yuval mentioned, there's two areas that we're investing during this downturn. One is in R&D where we continue to grow that and offset some of that in SG&A and keeping expenses in that $47 million to $48 million range. And the second is in broadening and strengthening our manufacturing profile that's invested in Malaysia. Those are the two big things that are affecting the margins from Q1 to Q2.

Great. That's really helpful. Maybe, Yuval, in terms of the semiconductor environment, I don't think you're saying anything particularly new in terms of the near-term environment, but given some of the comments you made in your prepared remarks regarding your customer mix and the changes there. How do you see the overall inventory levels from your customers because it sounded like, one is still working it off while another it appears to stabilize if anything you said that business picked up with the second customer. Can you just give maybe a qualitative, your qualitative thoughts on the inventory environment with your customers?

Sure. As you can see from our filing indeed we have different dynamic between our customers. And obviously we do not mention anything that has to do with our Asian customers, but we do see different profiles of demand driven by different levels of inventories and different type of products going to either memory or logic devices. In general, the way we view that is in it, for me it's an indicator that we're seeing stabilization right. We're at the point right now we see a mix in behavior of demand between different customers. Some of them continued to decline, some of them are recovering. We believe that the rest of the year, we will see revenue to semi fluctuating around the same level through the year. More precisely, I think we're talking about timing of inventory drawdown and customer mix and product mix that are changing differently between our customers. One area we saw a decline driven by the inventory correction are the Korean DRAM suppliers or equipment suppliers to DRAM. Obviously, with what's happening right now in DRAM, we expect the Korean OEM to see some challenges.

Our next question comes from Chris Carr from Cowen. Please go ahead.

Hi. This is Robert Mertens on behalf of Chris. Thank you for taking my question. Let's say, you've mentioned that you're prioritizing investment in these new technologies and ramping the R&D to along with customers' next-generation product roadmaps and capitalize when the semi market recovers. And if you look historically you've done a lot of smaller M&A. Where would you rank a potential dividend initiation on the totem pole of uses of cash? Is that something that you would consider or farther down the totem pole?

Yes. That would be certainly further down the totem pole for us. We've said that in terms of use of cash clearly our priority is to grow the business organically kind of goes without saying, but from an excess cash perspective, we continue to be very active evaluating acquisitions particularly those that might diversify our footprint and enable us to see accelerated earnings growth by having a broader, larger addressable market. Secondly, we would do that through opportunistic share repurchase. We did repurchase a lot of shares last year. If you recall, we bought back about $95 million worth of stock in the last year. We didn't buy back stock this quarter just given kind of where we saw operating cash flow in general. We decided to take a little bit of a breather. And then we certainly evaluate with our board our capital allocation, but we don't anticipate any dividend in our, certainly not in near future.

Okay. Thank you. And just one more question on the semi side of seeing the softness, a mix of the product mix customers and a bit of the inventory, but not seeing any sort of change in the market share standpoint. Could you just sort of quantify how you characterize you versus competitors in the market share and sort of the product timelines of when you can --when a socket versus potentially be designed out?

Sure. First of all, we are the undisputed market leader in a semiconductor, power delivery of components for years and continue to maintain our market share leadership. On top of that were being more recently than ever we continue to be pulled into collaborative work with our customers to develop next-generation power delivery systems. We're at the point right now in the industry where atomic level precision combined with the need for high throughput require a totally new design of equipment, reactors and power delivery systems. As a leader in the business and the technology leader, we continue to get engaged in those areas and the result of this engagement are design wins which will continue to win. The majority of the design wins we entertain and with that obviously we'll expect to see, expecting accelerated growth rate and addition of content of power capabilities, power suppliers and dollars into our customers' equipment.

Our next question comes from Mehdi Hosseini from SIG. Please go ahead.

Yes. Thanks for taking my question. A couple of follow-ups. How should we think about OpEx in the second half? Did you say it's going to track flattish to your Q2 guide?

Yes. That's right. We would expect, we've kind of set a target of $47 million to $48 million. We set that at the beginning of the year. Of course, we beat that a little bit this quarter, but that's the level we would expect to run in. And as I said earlier, we don't expect substantial increases from that even if revenues begin to recover. Obviously, there's a little bit of variable cost that would come in but fundamentally that's the target that we are shooting for the remainder of the year.

And then the same with the gross margin, as your volume shipping improves should we expect gross margins to track above the 45% -46% guidelines that you provided for Q2?

Yes. Certainly, we'll get leverage on the fixed cost and in gross margins, and we'll see improvement there. I will just note that the investment in the transition of the factory which last quarter we said we would expect to have a 50 to 100 basis point impact to margins during the transition period that will continue for several quarters until both factories are operating and then we will obviously rationalize between the two. We're not doubling capacity here. We're basically putting in place a strategy where we'll have the ability to move product from one factory to the other. And of course we'll continue to have the headwinds from tariffs which should come in since late last year and are impacting us. And we said that's a 50 to 75 basis point. So if you look down a year or so from now, when a couple of those, I'll say temporary items resolve themselves, our investment and hopefully the tariff environment, then we could see a little bit more improvement. But otherwise, we'll see the pickup from improved volumes as we go forward.

Sure. If I go back to 2017-2018, your semiconductor revenue was averaging $450 million a year. And your gross margin was well above 50. Is that the kind of leverage that we should expect as memory market for one turns, churns or comes back given your content to the memory market and market is more than other areas?

Yes. We don't see any reasons why in general margins in semi market are changed structurally. It's just the impact of volume right now.

Our next question comes from Pavel Molchanov from Raymond James. Please go ahead.

Thanks for taking the question. As the semi cap down-cycle persists longer than maybe a lot of people expected. I'm curious if this is creating any opportunities from an M&A perspective? And the genesis of the question was you've always said M &A will focus on industrials but or there are perhaps any distressed M&A opportunities on the semi cap side that you could take advantage of the down cycle for?

Hi, Pavel. Thanks for the question. Obviously, we continue to evaluate a pipeline of target acquisitions both tuck-in and but also bolt-on and bigger ones. The challenge about acquisition in the semi industry is twofold. Number one; there are not many targets of credible, viable companies that are in our domain. Number two, obviously with such an efficient and concentrated industry, we do not want to trigger any antitrust problem related to acquiring a similar company. So that limits the number of targets in semi general. Now, we continue to be a basically power conversion focused company, which allows us to be the leader in technology. The leader in the market. We see ourselves continuing to leverage our core competencies in power electronics. And for that reason unless something extraordinary happens with a target that would be an amazing not in power and in semi, I think we'll be inclined to go into the industrial world. Also, right now especially this year, we would rather focus on diversify our portfolio and be less concentrated in semi than more.

Okay. Understood. You highlighted solar as area of strength within the industrial segment. Geographically, where are you seeing those orders coming from? Is it kind of a traditional Asian PV manufacturing hub or is it perhaps some of the areas outside of Asia that are benefiting from the tariff situation?

So, Pavel, since we sell power supplies to companies that make solar cells. Our customers are mainly the equipment makers right. Those who make equipment that's being used to manufacture solar cells. We became really the leader in power supplies to go to both the crystalline and silicon cells but also thin films. Obviously, as you know, these projects can be lumpy and investment can occur in one quarter and then no investment in another quarter. That what happened to us now when we had a very strong delivery of a big project in Q1 and minimal revenue in solar in Q2. We expect the industry to continue to invest in capacity in the second half. We expect as continues to grow as we are right now the key supplier of a power supplier to go into these applications. End of Q&A

Thank you. This concludes our Q&A session. At this time, I'd like to turn the call over to Yuval Wasserman, President and CEO for closing remarks.

Thank you all for joining us today. Obviously, interesting times in the semiconductor industry. During this downturn, we continue to invest in the future of our company. Mainly in evolutionary and revolutionary products that we develop in conjunction with our key customers both semi and industrial, they will allow us to get out of this downturn with a stronger portfolio of products, with higher dollar content and broader served available market. I hope to see all of you sometimes in the next quarter. Thanks very much for your participation.

Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day.